U.S. Federal Reserve Leaves Rate Unchanged

WASHINGTON — The U.S. Federal Reserve Board, confronted with the perils of a slumping economy and rising inflation, has decided for a second straight meeting to leave interest rates unchanged.

The Fed announced Tuesday that it was keeping its target for the federal funds rate, the interest that banks charge each other, at 2 per cent.

The decision had been widely expected by financial markets. Shortly after the Fed announcement, the Dow Jones industrials was up 227 points at the 11,511 level.

The Fed is caught between what many economists believe is a recession and rising inflationary pressures, triggered by this year's huge runup in energy prices.

The Fed decision means that commercial banks' prime lending rate, the benchmark for millions of consumer and business loans, will remain unchanged at 5 per cent, its lowest level since late 2004.

The statement said that “tight credit conditions, the ongoing housing contraction and elevated energy prices are likely to weigh on economic growth over the next few quarters.”

The central bank also said it believes that “over time” the significant rate cuts it has already put in place plus the sizable operations to supply additional money to financial institutions should help to promote a return to “moderate economic growth.”

On inflation, the Fed said it expected a moderation in price pressures later this year and next year but cautioned that “the inflation outlook remains highly uncertain.”

The Fed also left rates unchanged at its last meeting on June 24-25, a decision that marked the end of the Fed's most aggressive period of rate cuts in more than two decades. Those reductions were engineered to protect the economy from turmoil in financial markets caused by billions of dollars of losses on home mortgages.

Many economists believe the Fed will leave the funds rate at 2 per cent for the rest of this year. The hope is that recent declines in oil prices will be sustained and take pressure off inflation without forcing the central bank to begin raising rates while unemployment has been rising sharply.

The Fed got good news on the inflation front Tuesday. Oil prices dropped as low as $118 (U.S.) per barrel, the cheapest they've been since early May. Crude has now fallen more than $25 since reaching a trading high of $147.27 on July 11.

Last week, the Labour Department reported that the U.S. unemployment rate jumped to 5.7 per cent in July as businesses laid off workers for the seventh straight month, a string that normally signals the start of a recession.

Those layoffs and the fragile state of the financial sector would normally keep the Fed from raising interest rates. Some Fed officials have been arguing, however, that the central bank runs the risk of losing its inflation-fighting credibility if it delays fighting growing inflation problems.

The government reported that a big surge in gasoline and food costs pushed consumer prices up by 1.1 per cent in June, leaving them rising by 5 per cent over the past year, the largest increase since 1991.